Spain's bid to avoid bailout dealt blow by rating cut

SPAIN’S EFFORT to avoid further rescue aid from Europe was dealt a new blow as a credit downgrade by Standard Poor’s led to renewed pressure on its borrowing costs.

The move overnight by SP, which now rates Spanish debt near junk, will make it more difficult for Madrid to regain the confidence of private investors.

Although prime minister Mariano Rajoy is in no rush to seek an increased bailout, some European officials believe the SP downgrade may bring a fresh aid application closer.

Spain’s 10-year bond yield finished down yesterday at 5.82 per cent but it temporarily approached 6 per cent after the downgrade. The yield was above the critical 7 per cent level before the European Central Bank adopted a new bond-buying campaign to help stricken countries.

Spain’s fate is crucial for Ireland. Its push for direct bank recapitalisations by the European Stability Mechanism was reflected in a resolution by EU leaders in June to break the seal between bank and sovereign debt.

Any direct ESM aid to Spanish banks would be designed to avoid a repeat of the Irish situation in which the bank bailout overwhelmed the State. Although Spain remains reluctant to go down that road, such a move could set a precedent for Ireland.

However, confidence in the June deal was undermined when Germany, Finland and the Netherlands declared that any ESM bank rescues would not deal with historic debts. SP cited this manoeuvre when cutting its rating on Spanish bonds to “BBB-/A-3” from “BBB+/A-2”, coming close to removing the “investment grade” status Spain needs to borrow on the open market.

The downgrade comes as EU leaders face calls to restate their June pledge at a summit next week in Brussels.

“Doubts over some euro zone governments’ commitment to mutualising the costs of Spain’s bank recapitalisation are, in our view, a destabilising factor for the country’s credit outlook,” said SP. “Our understanding from recent statements is that the euro group’s commitment to break the vicious circle between banks and sovereigns, as announced at a summit on June 29th, does not extend to enabling the ESM to recapitalise large ongoing European banks.

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“Our previous assumption . . . was that official loans to distressed Spanish financial institutions would eventually be mutualised among euro zone governments and thus Spanish net general government debt would remain below 80 per cent of gross domestic product beyond 2015.

“In our view, the capacity of Spain’s political institutions [both domestic and multilateral] to deal with the severe challenges posed by the current economic and financial crisis is declining, and therefore . . . we have lowered the rating by two notches.”

Spain is a potential beneficiary of the ECB decision to buy up unlimited amounts of sovereign bonds but it must apply first for a formal aid programme from Europe. Such a package would go beyond the credit line of up to €100 billion which Europe has already agreed to provide to Spain’s banks.

Recent stress tests suggested the banks need about €60 billion in new capital but the official position remains that private investors will provide €30 billion of that. This is viewed with scepticism by many observers.

Although many European officials believe the country may have little choice but to call on its euro zone partners, Germany has been insisting in recent weeks that Spain has no need for further aid.

The expectation remains, however, that Mr Rajoy will make his move some time after a regional election in Galicia on Sunday week.